A Regulatory Sandbox for Insurtechs?

A Regulatory Sandbox is the title given to the concept that regular regulations should not apply to insurtech companies. The reasoning is that technology can provide a better consumer experience than traditional carriers and distributors, particularly if the insurtech company or agency does not have to comply with all the rules and regulations. The sandbox rules are not just theoretical. While some people lament that the United States is not as permissive as Europe in creating sandboxes, the United States clearly has them.

How else can the lack of enforcement on the benefits broker who purposely avoided obtaining insurance licenses and went so far as to create software to hide their lack of licenses from regulators be explained? Some states eventually handed out fines but not all states did. That is a sandbox. They don’t have to have licenses, but everyone else does.

By the way, that is not an issue that technology supersedes. Regardless of who or what is giving advice, a license is meant to help emphasize the person or entity has at least a modicum of knowledge and has passed a background check. “Technology” does not obviate this point.

Another way of stating this is to ask the question, “How is technology delivering a better consumer experience, including a safer consumer experience, when the people that work for that technology company who are the live entities delivering advice, do not need licenses?”

The technology argument is ridiculous.

Rebating

In another example rebating was allowed because the “agent” was “really” a technology HR company selling insurance on the side. That was the political decision. Rebating is rebating (although, as former President Clinton emphasized in one of his depositions, “is” has amorphous meaning so maybe rebating does too). Technology has nothing to do with rebating other than maybe speed the delivery of the rebates.

Some evidence exists of non-actuarial pricing being employed. This is evident in many areas. An obvious one is the difference between new business and renewal pricing. Another example is reading the advertisements of the analytic firms promising favorable pricing models without any mention of actuarially based pricing. I cannot prove anything but based on the correlations between what I see happening in the real world and then reviewing certain insurance companies’ income statements, some carriers certainly seem more successful than others relative to their pricing models. I know this is not ever approved categorically by regulators, but assuming it is happening, it can more easily happen today because companies and their programmers can hide it more easily. Some people believe 100 percent actuarial based pricing is passe anyway.

Wolf in Sheep Clothing

Should a sandbox be created for new companies using steroid effected pricing models? What is the outcome if they write a lot of premium that is massively underpriced? Who pays the piper? Why is technology even required as a consideration for obtaining a special regulator exemption? As the industry has proven for decades, technology is not required to massively underprice.

I have yet to see, read, or experience a situation where existing regulators hindered a technology-based carrier or distributor in any special way. Whatever regulation frustrated these insurtech players or whatever is frustrating them enough to call for special sandbox regulations frustrates traditional players, too.

This sandbox concept is the epitome of a wolf in sheep clothing. Players, not just new ones, are using technology as a guise to skirt regulations that have a solid, important purpose. Nothing magic exists in technology allowing a “technology” based entity to responsibly and ethically deliver insurance products by exempting them specifically from these regulations.

For example, licensing is important regardless if the agency is virtual or brick and mortar. Maybe licensing is even more important if the agency is virtual. In a brick and mortar agency, consumers have an opportunity to know and to meet the person. They see the person to whom they can complain. The people live in their town and can be reported to their state’s regulator easily. How does a person report a “bot”?

Rebating is controversial on many levels. Maybe the concept is even somewhat outdated, but then it is outdated for the industry, not just insurtech. Nothing special exists relative to technology vs. brick and mortar agencies relative to rebating and delivering a better consumer experience.

Maybe it is time to revisit the anti-disparagement rules, too, because I’m seeing indications that certain entities who may play a little looser with the rules, not just technology-based carriers either, are using these rules to protect their behaviors.

It also looks to me the way these rules work or are being enforced is a little one sided. These new companies seem quite able to knock traditional players without fear on prices, rates, service, etc., but one has a difficult time pointing out their poor forms, their forms that may violate copyright laws, their financial situations, or their overall corner cutting. Do they really need special protection to cut such important corners? The time may be right to revise these rules.

Not Good On Any Level

I feel for regulators because pricing is such a difficult, contentious and socially vital issue, especially in personal lines. If these firms demanding sandbox regulations are allowed to cherry pick, if any companies are allowed to cherry pick, by pricing exactly to the risk or through the use of non-actuarial based pricing, a material segment of the population may be faced with less affordable or completely unaffordable insurance. This is not good on any level, including the UM/UIM aspect. Industry veterans remember how horribly the state government solution/takeovers were in the 1970s to 1990s when insurance became too expensive for too many constituents.

Capitalization is of real concern on two levels: the balance sheet and the income statement. The concern on the balance sheet level is that capital is required to pay claims. I am starting to see the idea that technology companies do not need as much capital with which to pay claims. That argument is hard to buy because claims are claims unless the technology will reduce claims. In that case:

Will rates decrease? Almost certainly rates will decrease meaning capital may need to increase for all the new business written because their rates are so competitive. More capital, not less capital is required for growth.

Will claim practices remain fair? Everyone’s definition of fair varies depending on which side of the table they face. Maybe a better way of posing this question is, if the same claim and same policy provisions (or maybe their policies will be skimpier?) exist, will many other companies pay more for the same claim?

Another interesting balance sheet argument being made is that regulators should

Regulatory sandboxes are a Trojan horse.

allow a greater variety of investment without discount. I am seeing inklings of using Fair Value accounting. Fair Value accounting can be more easily massaged. Maybe it is okay for investors and mergers and acquisitions, but that is quite another for policyholders. Insurance is meant to be solid, not sexy.

On the income statement side, the argument is being made by many, including old companies, that expenses will be less in the future because technology is going to increase productivity exponentially. This will result in more profit, and with that profit, more money can be assigned to surplus, which in turn, requires less initial capital. That is a neat argument and it has potential, assuming management and shareholders will leave the profits in the companies. While every company can leave profits on the balance sheet and use it to build surplus, many companies do not do this. They do not even pretend to do this, so I have my doubts about this argument being universally realized.

Another reason to doubt the efficacy of this argument is that if rates decrease because expenses are lower and the company then writes more business, it needs more capital to support the extra writings!

I just do not buy into the idea any of these “technology” companies are so smart they can deploy capital so much more intelligently that they can truly protect policyholders with materially less capital. Math is kind of neat this way.

Regulatory sandboxes are a Trojan horse. I hope regulators and the industry keep Troy’s gates closed.